Testing for mean reversion in heteroskedastic data II: Autoregression tests based on Gibbs-sampling-augmented randomization

A decade ago Fama and French [Fama, E.G., French, K.R., 1988. Permanent and temporary components of stock prices. J. Political Econ. 96 (2) 246–273] estimated that 40% of variation in stock returns was predictable over horizons of 3–5 yr, which they attributed to a mean reverting stationary component in prices. While it has been clear that the Depression and war years exert a strong influence on these estimates, it has not been clear whether the large returns of that period contribute to the information in the data or rather are a source of noise to be discounted in estimation. This paper uses the Gibbs-sampling-augmented randomization methodology to address the problem of heteroskedasticity in estimation of multi-period return autoregressions. Extending the sample period to 1995, we find little evidence of mean reversion. Examining subsamples, only 1926–1946 provides any evidence of mean reversion, while the post war period is characterized by mean aversion. A test of structural change suggests that this difference between pre and post war periods is significant.     

Nonlinear mean reversion in stock prices

This paper provides new evidence on the time-series predictability of stock market returns by introducing a test of nonlinear mean reversion. The performance of extreme daily returns is evaluated in terms of their power to predict short- and long-horizon returns on various stock market indices and size portfolios. The paper shows that the speed of mean reversion is significantly higher during the large falls of the market. The parameter estimates indicate a negative and significant relation between the monthly portfolio returns and the extreme daily returns observed over the past one to eight months. Specifically, in a quarter in which the minimum daily return is −2% the expected excess return is 37 basis points higher than in a month in which the minimum return is only −1%. This result holds for the value-weighted and equal-weighted stock market indices and for each of the size decile portfolios. The findings are also robust to different sample periods, different indices, and investment horizons.     

Persistence and mean reversion in UK stock returns

This paper re-examines the issue of persistence and mean reversion in UK stock returns in the light of new developments published in Chow and Denning (1993) the random walk hypothesis is tested using multiple variance ratios for returns on the Financial Times All Share Index and 330 individual stocks for the period January 1965 to June 1994. There is no evidence of reversion in the UK stock market. Persistence only exists in high frequency data and is less strong in more recent times. Moreover, it is a portfolio phenomenon and is related to firm size. There is a possibility that persistence/reversion is also industry-related.     

Modelling fundamental analysis in portfolio selection

We derive a closed-form appraisal/information ratio of the investors who are able to observe some information about security fundamentals, by solving a simple instantaneous mean-variance portfolio choice problem in a continuous-time framework. Both analytical and numerical results suggest that investors should choose securities with a more volatile mispricing, a less volatile fundamental, a higher mean-reverting speed and a larger dividend. Our model calibrated with realistic parameters easily outperforms top-percentile portfolio managers in reality, which suggests that the implementation of fundamental analysis may be impeded in practice due to limits of arbitrage. Our paper is a first, necessarily simple, step towards filling the gap of modelling fundamental analysis in portfolio selection.     

On the positive fundamental value of money with short-sale constraints

This paper is concerned with the pricing of money in a framework with restrictions on trading, under an extension of the standard-asset pricing theory that recognizes both tangible and intangible returns. It is argued that the underlying motivations for demanding money give content to its fundamental value and the bubble component. This approach is illustrated by analyzing the case where no short-sales are allowed, as two examples from the literature are made used to assert that money is a pure pricing bubble. Owing to this setup exhibits technically incomplete financial markets, the fundamental value of money is not uniquely defined over the set of generalized state-price processes. Then, these examples are shown to comprise an extreme case, as money is a pure store of value for the state-prices chosen (i.e., it is a pricing bubble). Instead, the fundamental value of money can be positive for other state-prices, representing the role of money in the trading process. Therefore, money should not be considered the equivalent of a pure pricing bubble.      

Dependence and mean reversion in stock prices: The case of the MENA region

This paper provides empirical evidence on the long memory behavior of the stock markets of Egypt, Jordan, Morocco, and Turkey. To test for long memory in the returns and volatility, we employ the modified rescaled range statistic R/S proposed by Lo [Lo, A.W., 1991. Long-term memory in stock market prices. Econometrica 59, 1279–1313] and the recently proposed rescaled variance V/S statistic developed by Giraitis et al. [Giraitis, L., Kokoszka, P.S. Leipus, R., Teyssiere, G., 2003. Rescaled variance and related tests for long memory in volatility and levels. J. Econ. 112, 265–294]. Further analysis is conducted by employing the ARFIMA (p, d, q) model to estimate the long memory parameters. Egypt and Morocco show evidence of long memory in the return series, while Jordan and Turkey display negative persistence. For the volatility series, long memory is conclusively demonstrated for all markets. Then, we compare the forecasting performance of ARMA and ARFIMA models and find that the ARFIMA model outperforms in out-of-sample forecasting of the markets. Our results should be useful to regulators, practitioners and derivative market participants, whose success depends on the ability to forecast stock price movements in these markets.     

Modeling the behavior of real asset prices

Recently there has been much research treating housing and other real assets as financial claims, primarily in order to value their derivative assets, such as mortgages and mortgage-backed securities. Real asset prices are then typically modeled as a lognormal process, in the same manner that has traditionally been applied to firm value. The service flow or implicit value of a house is thus considered, in analogy with stock dividends, to be a fixed proportion of the fluctuating house price. We consider the appropriateness of this formulation and draw some distinctions between real assets, such as a house, and investment enterprises, such as a firm. We then propose an alternative method of formulating the service flow and the price of real assets which seems more appropriate to the economic characteristic of such assets.     

A tale of two prices: Liquidity and asset prices in multiple markets

This paper investigates the liquidity effect in asset pricing by studying the liquidity–premium relationship of an American depositary receipt (ADR) and its underlying share. Using the [Amihud, Yakov, 2002. Illiquidity and stock returns: cross-section and time series effects. Journal of Financial Markets 5, 31–56] measure, the turnover ratio and trading infrequency as proxies for liquidity, we show that a higher ADR premium is associated with higher ADR liquidity and lower home share liquidity, in terms of changes in these variables. We find that the liquidity effects remain strong after we control for firm size and a number of country characteristics, such as the expected change in the foreign exchange rate, the stock market performance, as well as several variables measuring the openness and transparency of the home market.     

The impact of monetary policy on asset prices

Estimating the response of asset prices to changes in monetary policy is complicated by the endogeneity of policy decisions and the fact that both interest rates and asset prices react to numerous other variables. This paper develops a new estimator that is based on the heteroskedasticity that exists in high-frequency data. We show that the response of asset prices to changes in monetary policy can be identified based on the increase in the variance of policy shocks that occurs on days of FOMC meetings and of the Chairman's semi-annual monetary policy testimony to Congress. The identification approach employed requires a much weaker set of assumptions than needed under the “event-study” approach that is typically used in this context. The results indicate that an increase in short-term interest rates results in a decline in stock prices and in an upward shift in the yield curve that becomes smaller at longer maturities. The findings also suggest that the event-study estimates contain biases that make the estimated effects on stock prices appear too small and those on Treasury yields too large.     

The impact of portfolio diversification on mean reverting components of stock indices

Positive autocorrelations are introduced into stock index portfolios when they are formed from individual stock indices while negative autocorrelations are induced in returns by increasing the investment horizon. Using monthly data of six international stock indices, this paper examines the diversification effect with different investment horizons on autocorrelations of stock index portfolios. The results show that portfolio diversification does not alter the impact of the investment horizon on autocorrelations. Different investment horizons, however, have great impact on the diversification effect on autocorrelations. With short (long) horizons, the average autocorrelation coefficient increases (decreases) with an increase in the portfolio size, suggesting that mean-reverting component dominates the delayed adjustment effect in long horizons and vice versa in short horizons. Our results are robust across two 10-year sub-periods.The author would like to thank an anonymous referee of this Journal for the comments on an earlier version of this paper and the Research Committee of Hong Kong Baptist University for the financial support in this research.     

中国城市住房价格动态特征及其影响因素

本文从理论和实证两个层面分析了1997-2007年中国35个大中城市的房价动态特征,并考察了城市因素对房价动态参数的影响。所得主要结论有:中国城市房价具有强序列相关和弱均值回归特征;住房使用成本、地区市场化指数、土地交易价格指数及其变化对序列相关系数有显著影响;真实收入及其变化、建造成本、地区市场化指数对均值回归系数有显著影响;各城市的房价动态参数拟合值几乎全部落入震荡收敛区内,东部城市房价的波动振幅普遍高于中西部城市;1999年后35个大中城市的平均房价波动振幅有逐渐增大的趋势,尤其是2007年的房价波动振幅出现了非正常增长,但波动频率变化幅度不大。     

Advisors and asset prices: A model of the origins of bubbles

We develop a model of asset price bubbles based on the communication process between advisors and investors. Advisors are well-intentioned and want to maximize the welfare of their advisees (like a parent treats a child). But only some advisors understand the new technology (the tech-savvies); others do not and can only make a downward-biased recommendation (the old-fogies). While smart investors recognize the heterogeneity in advisors, naive ones mistakenly take whatever is said at face value. Tech-savvies inflate their forecasts to signal that they are not old-fogies, since more accurate information about their type improves the welfare of investors in the future. A bubble arises for a wide range of parameters, and its size is maximized when there is a mix of smart and naive investors in the economy. Our model suggests an alternative source for stock over-valuation in addition to investor overreaction to news and sell-side bias.     

Why panel tests of purchasing power parity should allow for heterogeneous mean reversion

Recent studies of purchasing power parity (PPP) use panel tests that fail to take into account heterogeneity in the speed of mean reversion across real exchange rates. In contrast to several other severe restrictions of panel models and tests of PPP, the assumption of homogeneous mean reversion is still widely used and its consequences are virtually unexplored. This paper analyzes the properties of homogeneous and heterogeneous panel unit root testing methodologies. Using Monte Carlo simulation, we uncover important adverse properties of the panel approach that relies on homogeneous estimation and testing. More specifically, power functions are low and assume irregular shapes. Furthermore, homogeneous estimates of the mean reversion parameters exhibit potentially large biases. These properties can lead to misleading inferences on the validity of PPP. Our findings highlight the importance of allowing for heterogeneous estimation when testing for a unit root in panels of real exchange rates.     

The impact of keeping up with the Joneses behavior on asset prices and portfolio choice

This paper studies the asset pricing and portfolio choice implications of keeping up with the Joneses preferences. In terms of portfolio choice, we provide sufficient conditions on the utility function under which no portfolio bias can arise across agents in equilibrium. Regarding asset prices, we find that under Joneses behavior asset prices are a function of the economy's aggregate consumption, the agents preference parameters, the wealth endowment distribution and the weighting across agents in the Joneses definition. We present necessary and sufficient conditions such that equilibrium prices are only a function of aggregate wealth. Non-financial, non-diversifiable income is introduced in the model. In the presence of Joneses behavior, an under-diversified equilibrium emerges where investors will bias their portfolios towards the financial assets that better hedge their exposure to the non-financial income risk.     

The influence of the CEO's value perception towards auditing on audit demand in private firms

Audit demand is generally considered to be a direct reflection of the level of agency conflicts. This study examines the CEO's value perception towards auditing as additional driver for both auditor reputation demand (appointing a Big 4 auditor or not) and audit effort demand in private firms. Examining the CEO's value perception in a multidimensional way, the regression results indicate that the CEO's functional value perception towards auditing positively affects the demand for audit effort, while the CEO's social value perception towards auditing negatively affects the demand for audit effort but positively affects the demand for auditor reputation.     

Modelling the economic value of credit rating systems

In this paper we develop a model of the economic value of credit rating systems. Increasing international competition and changes in the regulatory framework driven by the Basel Committee on Banking Supervision (Basel II) called forth incentives for banks to improve their credit rating systems. An improvement of the statistical power of a rating system decreases the potential effects of adverse selection, and, combined with meeting several qualitative standards, decreases the amount of regulatory capital requirements. As a consequence, many banks have to make investment decisions where they have to consider the costs and the potential benefits of improving their rating systems. In our model the quality of a rating system depends on several parameters such as the accuracy of forecasting individual default probabilities and the rating class structure. We measure effects of adverse selection in a competitive one-period framework by parameterizing customer elasticity. Capital requirements are obtained by applying the current framework released by the Basel Committee on Banking Supervision. Results of a numerical analysis indicate that improving a rating system with low accuracy to medium accuracy can increase the annual rate of return on a portfolio by 30–40 bp. This effect is even stronger for banks operating in markets with high customer elasticity and high loss rates. Compared to the estimated implementation costs banks could have a strong incentive to invest in their rating systems. The potential of reduced capital requirements on the portfolio return is rather weak compared to the effect of adverse selection.     

财产保险的保险价值界定探析——解读新《保险法》第55条

保险价值在财产保险中占有核心地位,是确定赔付比例和赔偿限额的标准。在实务和媒体报道中,财产保险索赔争议案例多与对保险价值的不同理解有关。本文将通过案例分析保险法和保险条款对保险价值界定中存在的问题,并对保险价值相关立法和司法解释的进一步完善提出合理建议。     

The value of combining the information content of analyst recommendations and target prices

In assessing the usefulness of the analysts’ stock picking advice, the extant literature has largely focused on the profitability of either their stock recommendations or target prices in isolation. In this paper, we examine the profitability of investment strategies that exploit the information analysts convey through revisions in both their stock recommendations and target prices. We find that these strategies significantly outperform the comparable strategies that make use of only one analyst output.     

Economic value of analyst recommendations in Australia: an application of the Black–Litterman asset allocation model

This study empirically examines the investment value of security analyst recommendations on constituent stocks of the S&P/ASX 50 index. We find that stocks with favourable (unfavourable) recommendations on average outperformed (underperformed) the benchmark index. An investment strategy using the Black–Litterman asset allocation model that incorporates consensus analyst recommendations, in conjunction with daily rebalancing, outperforms the market in terms of return and risk‐adjusted performance measures. The investment strategy involves high levels of trading, and no significant abnormal returns are achieved after transaction costs. Less frequent rebalancing, under most situations, causes a decrease in both performance and turnover. Filtering of dated recommendations causes an increase in turnover, while having mixed effects on investment returns.